Vote Party Poopers

November 16, 2012

Well, the election is finally over. So what will be the impact on the market for the next four years? 

The market has been weak for about a month now – a 7% drop that began a few weeks before the election and continued immediately after.

Of course, it’s not like the election outcome caused the slide. Obama never really looked like he was in much danger of losing. If anything, Romney’s late rise in the polls coincided with the down market. Besides, if four more years of the same president were such a downer for stocks, why were the first four years among the best of any president in history? Something more inevitable must be at work.

Historically, stocks have performed better under Democrats than under Republicans. No one really knows why. It could be a multi-decade statistical anomaly. It could be that the market – which is ultimately driven by earnings – likes some income redistribution in the form of higher taxes on the well-to-do. Maybe not 75% tax rates like France just laid down, but a rate that moves money from the investor class into the spending class.

As long as that tax rate's not so high that it discourages more work by the top, it would likely boost earnings for all of the companies we invest in that sell stuff to consumers. Don’t get me wrong. I'd rather invest my extra money than have someone else spend it, but more consumption and less investment means fairly-priced stocks and faster earnings growth. 

If we had plenty of what economists call "aggregate demand" and a lack of investor capital available to grow a business or increase production cheaply, such a move of money from investors to spenders could spell disaster.

The scary part of this election wasn’t the differences between the economic policies of the Republicans and Democrats (since the economy doesn't really change as much as feared by the losing party either way.) 

But the latest versions of both parties’ platforms seem to be soundly based on economic magical thinking. Either they say, "We can spend what we want, because if the very top pays a little bit more, it will erase deficits" OR "We can cut taxes ever more with limited spending cuts, because resulting economic growth will end the red ink."

The party that should win is the Party Pooper Party, the one that gives voters a reality check – not nearly as fun as hocus-pocus economics. The Party Pooper Party never wins elections, though, because voters want to believe in magic. 

Do you really believe the President doesn’t know tax increases on the few won't be enough to balance a now-perpetually large budget gap? You think Mitt Romney doesn’t know exactly what needs to be cut from spending or removed from tax expenditures in order to balance the budget? They both know. They also know that we just can’t handle the truth.

The truth is, the only realistic way to close our budget deficit is by instituting a mix of sharp spending cuts and uncomfortable tax increases. The alternative – kicking the can down the road – would deliver a harsh market solution in which our government wouldn't be able to borrow at favorable rates anymore. That would lead to one of two scenarios. Either we'd have to institute sharp, sudden austerity measures, or we'd see inflation at wildly increasing levels, the result of central bank purchases of government debt.

The silver lining to this harsh reality is that the ones lending us money don't expect much interest over the long life of a bond. So as long as the government is taking steps to pay off the loans over time, the progress in budget repair doesn’t have to be overnight. We can have a tax plan that combines rate increases and/or deduction erosion with spending cuts that kick in gradually.

Our biggest black holes, Medicare and Social Security, can be fixed by gradual – even glacial  benefit reduction. Just pushing out eligibility a few years and indexing it to average mortality makes much of the problem go away. But politicians have to be able to talk about taking these measures without losing elections. Budgets need to be fixed over periods lasting longer than election cycles, or they'll be dealt with the hard way – by the marketplace –in a short, sharp shock. 

In the meantime, don’t be afraid to invest because your party lost and you think the world is going to heck in a handbasket. It doesn’t matter who wins as long as we can get back to running a balanced budget in good times and save the deficit years for actual recessions. When your party loses, you may not like how the budget hole gets fixed, but if it gets fixed the right way – slowly, but surely – you'll do just fine over time. Investors need only fear a perpetual deficit with no realistic plan in place to fix it – for now, still a legitimate fear.


Anonymous — POSTED November 18th, 2012 5:31PM

You could Cut the libral talk in your market commentary (first couple paragraphs). The rest is common sense but if you're going to bring up topics like such a great market rebound with Obama you must also discuss the massive slide that preceded due to the housing and banking crisis which was largely caused (or at very least the foundation for which was laid by) liberal policies set back under Clinton. Lets be balanced if we're going into politics and the market.

Spot on common sense and
Anonymous — POSTED November 17th, 2012 1:47AM

Spot on common sense and honesty.

The idealist in me believes that a true political leader could state his and start addressing it.

The realist recognizes that 24 hour spin factories dont like truth and 'fixes' but prefers the "us" vs "them" and the "we win, you lose" crap.